Follow us:

Will U.S. Online Sales Tax Mandate Hurt Small Business?

Struggling states and some brick-and-mortar retailers have reinvigorated an effort to mandate that online merchants collect sales taxes for all U.S. jurisdictions, whether or not those retailers actually have operations there.

The most recent legislation is the so-called Marketplace Fairness Act that, according to its sponsors, seeks to undue online retailer’s competitive advantage and make it possible for states to collect an estimated $20-to-$40 billion in additional taxes.

The legislation and the suggestion that online businesses should collect sales taxes from every state (and every county and city), has sparked arguments, spurred aspersions from all sides, and led many to ask, “In a struggling economy, will mandated sales tax collection hurt small businesses?”

What Is Small Business?

The proposed legislation includes a “small seller exception.” This exception states that if a merchant had less than $500,000 in remote sales — which are sales to jurisdictions wherein the merchant has no operations or agents — in the previous year that merchant will not be required to collect additional remote sales taxes.

This clause effectively defines what a small online business is, and provides some protection for startups and entrepreneurial ventures. It is an olive branch to the smallest of businesses and to business advocates that claim the Internet sales tax mandate would make it significantly more difficult to start a new online business and place on onerous burden on retailers.

As an example, imagine that a merchant had exactly $500,000 in remote sales. Next, imagine that this merchant earned about 20 percent over the cost of goods sold, payment processing fees, and the shipping offset — since more than half of online sales now include free shipping. This hypothetical retailer would have $100,000 in “profit” dollars before general overhead.

Something like 7-to-10 percent of revenue should be (must be) reinvested in marketing, such as pay-per-click advertising and email. The retailer earning $500,000 per year could be spending $35,000 on all marketing, meaning that the business would have $65,000 “profit” dollars left to pay employees, lease server space, maintain an SSL and other security, pay for accounting services, and pay income taxes or office rental.

Comparing Competitive Advantages

“The people who have the bricks-and-mortar retail establishments are collecting sales tax in every state as they are required to by law,” said Sen. Richard Durbin (D-IL), one of the Marketplace Fairness Act’s sponsors, in a recent CNBC interview.

“That sales tax, of course, sustains local services and the functions of government, but the Internet sales in those same states are not, in many cases, collecting that same sales tax, so there is a competitive advantage for the Internet retailer over the bricks-and-mortar person.

“As you meet with these shopkeepers and retailers around my state, they say, ‘This is totally unfair we are required by law to collect it. The Internet sales are not.’”

Durbin’s argument — that not having to collect sales tax is an advantage — has been a rallying cry for some retailers and retail organizations.

In the past, some of these same organizations and individuals have also complained that online merchants enjoy lower start up costs, lower overhead, and lower marketing costs. Meanwhile, online retail advocates point to merciless shipping costs, the burden of paying for return shipping, card-not-present fraud related costs, and the difficultly in getting vendor relationships as some of online retailing’s clear disadvantages compared to traditional stores. And online retailers must already collect sales taxes in any jurisdiction wherein they do have operations.

Regardless of what one believes relative to which type of retailer is better positioned in the marketplace, Durbin’s underlying assumption is that impeding online retailers — since taking away a market defined competitive advantage will certainly retard a business segment — is better for small business and for the U.S. Economy.

The Burden of Tax Collection

The U.S. has something like 9,000 tax jurisdictions. Each of these states, counties, townships, cities, or villages has different tax requirements and separate tax reporting forms and procedures.

Thanks to a 1992 ruling in the case of Quill Corp. versus North Dakota, at present online merchants only have to collect sales taxes in those select few jurisdictions wherein they have a physical location or agent.

The idea was that it would be both absurd and impossible to manage a system that required a merchant to know and comply with every far-flung taxing body.

Nonetheless, this is exactly what is being proposed now.

If this new legislation becomes law, an online retailer might need to identify each and every tax jurisdiction and keep up with every tax change. This could mean that if just 30 percent of tax jurisdictions (assuming the aforementioned 9,000 total jurisdictions) made a single change to their tax code or even paper work once every five years a national online retailer would need to up date its sales tax collection procedures twice a day, every business day, forever and ever.

This example is, of course, extreme since this same retailer would also need to be shipping products into each jurisdiction in order to be subject to the mandate to collect sales taxes there, but hopefully the point is clear. This proposed law is asking a lot.

At the same time, it is likely that services will become available — Avalara is a company that provides this sort of comprehensive sales tax service already — to seamlessly manage sales tax collection across all of these tax-collecting jurisdictions in the country.

In fact, it would be reasonable for an organization like the National Retail Federation to maintain an open source database of all tax jurisdictions that online merchants could access via an application programing interface.

Tax collection automation could offset most of the burden that the new law represents, and it would not be a surprise to see software-as-a-service ecommerce platforms provide these services as part of basic ecommerce packages.

A second part of the burden this legislation might represent is that online retailers would have to pass this tax on to customers, who would have to pay more for their purchases. Given the possibility of additional shipping charges and the necessity of waiting for a product to arrive via FedEx or the U.S. Postal Service, it may be the case that online buying will, as Durbin hopes, loose some of its luster, driving online shoppers into local stores.

Summing Up

As the U.S. economy continues to struggle, a debate has risen over whether online merchants ought to collect sales taxes for every jurisdiction into which products are shipped regardless of whether or not the merchant has a location or agent in that jurisdiction.

The underlying premise behind this proposed legislation is that forcing sales tax collection would be better for struggling or bankrupt local and state governments and better, in general, for small business.

Determining if this proposed law would achieve its goal, may come down to three considerations.

First, what is small business. Is small business the brick-and-mortar storekeeper or the garage-based entrepreneur? Is small business the regional strip mall merchant or the similar sized online seller?

Second, does it make sense to slow down ecommerce, which has been out pacing the economy, in order to tow along under-performing physical stores?

Third, is the law actually a burden to online businesses? If it is just to impede online retailing in order to encourage in-store retailing, does the law go far enough to level the proverbial playing field or will automation marginalizing its effect?

Sign up for our email newsletter

Comments ( 7 )

Thank you for covering this important issue with such a well researched article. I just wanted to point out that there are other companies than Avalara doing sales tax management. In fact there is even one that is completely free for retailers: TaxCloud.

TaxCloud was designed from inception to resolve the burdens cited by the Supreme Court, and is even paid for by the states so no retailers are burdened by cost or complexity. TaxCloud is an easy-to-use web service, so no big software or database is required. All that is required is configuration of the shopping cart or order management platform.

Regarding your question about small businesses related to the small seller exception included in the bill, it is important to note that NO small business exception is available for bricks-and-mortar retailers – they are ALL required to collect sales tax on their very first sale. Neutral tax policy should treat all taxpayers and all transactions the same, regardless of the forum or medium of sale.

It is disingenuous to compare taxing a small B&M shop with taxing a small internet business. The small B&M shop has a single tax location and thus pays a single tax. The poor small internet operation could potentially need a different tax rate, different tax return, different place to pay the tax, for each and every sale. It is a MASSIVE administration burden. It would probably cost more to collect and police than it raises for the smaller business.The need for a cutoff exemption is clear. It saves money.

The point to watch out for is that any small business approaching the limit will certainly loose a lot of profit the second they tip over the line. It will encourage businesses to try to artificially split their income, and have sales/holidays for a couple of weeks to keep below the line. It occurs here in the UK when businesses approach the VAT limit (about $110,000) because as soon as they breach the limit they have to charge VAT which is a 20% sales tax.

First of all great summary of both sides of the issue here. Many people attempt to screw the discussion one way or another to favor their position. As an online retailer that also has a traditional brick and mortar store like many people these days I agree with Richard. I personally is not apposed to collecting the tax on online sales. That really is not the point. Online retailers are really at a disadvantage anyway with shipping cost skyrocketing and the fact customers have to wait on their orders.

The real issue for me the small online retailer is not a lack of willingness to comply, but the unmanageable administrative burden of managing, collecting and filing taxes for literally thousands of jurisdictions. The traditional retailer has a physical presence in a particular area. They may have multiple locations and may even cross jurisdictions, but not the less they have a presence and should know the local laws and are in a better position to handle the burden.

However, the small online retailer may have sales in thousands of locations making it virtually impossible for them to be in compliance. On top of that, I believe we are in one of the greatest times for entrepreneurs in our country and it is a time when the economy really needs a shot in the arm. As people are loosing their jobs or need extra money to make ends meet the cost of technology make it so much easier for them to start their own business. Most businesses started at one time as a small business. I sure would hate to see the government to be so short sighted not to see this.

While an online sales tax collection requirement will hurt small online merchants, many have already been injured by the state-by-state approach. Thousands of small affiliates have been shed by Amazon and other large online retailers and their revenues have plummeted. Some have moved out of states that have implemented online sales tax collection. For example, FatWallet.com, an Amazon affiliate, moved from Illinois to Wisconsin last year. While the move was just a few miles, they had a long-term lease in Illinois. Uniformity would be more equitable.

I believe online sales tax is necessary as E-commerce activities do utilize public resources to some extent, however, it should be a simple structure and the rate should reflect the level of public resources online transactions incur. Just a simple flat rate, filed with a centralized agency, reporting simply break-down of sales to various states, and total tax collected, and let the central agency distribute the tax revenue to states and municipalities. This way we (sellers, buyers, gov’t) all come out ahead.

I believe that if this legislation is enacted and no measure is put into place to simplify the tax collection for each state to the "state" and not "local" level that tens of thousands of eCommerce retailers will be forced to reevaluate their business model.

Adding the requirement to collect and pay quarterly and monthly taxes across the entire US will put a huge burden on most eCommerce businesses. Even if there are automated solutions as suggested, there will be a significant new cost introduced into the operating costs. On top of that, sales revenue will likely be negatively impacted by leveling the playing field with local brick and mortar stores. Free shipping will become even more imperative.

The result will be that merchants just over the small business revenue limit, $500K or $1M depending on the versions of the bill we are looking at, and under $25 Million or so may be forced to do a eCommerce platform upgrade, change their business model, or simply exit the business altogether. Platform upgrades, as well as the processes to support payments, will put a very large burden on already tight cash flows and lean operations.

Ultimately, states will be the winners by collecting more taxes and consumers will be the losers as their prices will go up. Brick and mortar stores have so many other issues that are impacting their businesses, I don’t believe they will see any great benefit. Small eCommerce merchants will carry the burden of delivering states more tax revenue and that is just simply unfair.

One last note, the notion that brick and mortar local businesses are somehow burdened more than eCommerce businesses on the tax side is ridiculous. All eCommerce businesses collect the same local taxes that a brick and mortar stores does already. A local business will not be responsible for setting up a tax collection and payment system for 50 different states and unknown local governments, so they will be at a large advantage again from an operating cost perspective.

If I were an eCommerce business in the $1M-15M size range, I would very seriously consider getting bigger or smaller through mergers or acquisitions or a breakup of the company into smaller units with less than $500K in sales. That way you are large enough to support the tax collection systems or small enough to avoid it altogether.